Valuation: Accounting for Risk and the Expected Return

25 Pages Posted: 20 Apr 2016

See all articles by Stephen H. Penman

Stephen H. Penman

Columbia Business School - Department of Accounting

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Date Written: March 2016


Under accounting principles, the recognition of earnings is path‐dependent and the path depends on risk and its resolution: under the so‐called realization principle, earnings are not booked until uncertainty is resolved. In asset pricing terms, the principle means that earnings cannot be recognized until the firm can book a low‐beta asset such as cash or a near‐cash discounted receivable. If the risk to which this accounting responds is priced risk, the accounting indicates the expected return. This paper connects accounting under this principle to risk and return, summarizes the supporting empirical evidence, and examines the implications for research on the implied cost of capital, cash‐flow betas, asset pricing models that imbed accounting numbers, and papers that assume an autoregressive model for the earnings path to infer the expected return. The accounting that captures risk and its resolution also has implications for the unsolved issue of specifying the appropriate accounting for accounting‐based valuation models and, indeed, for financial accounting standards.

Keywords: Accounting and risk, Accounting and valuation, Expected return, Risk

Suggested Citation

Penman, Stephen H., Valuation: Accounting for Risk and the Expected Return (March 2016). Abacus, Vol. 52, Issue 1, pp. 106-130, 2016. Available at SSRN: or

Stephen H. Penman (Contact Author)

Columbia Business School - Department of Accounting ( email )

3022 Broadway
New York, NY 10027
United States
212-854-9151 (Phone)
212-316-9219 (Fax)

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